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Country Default Risk: An Empirical Assessment

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  • Jerome L. Stein
  • Giovanna Paladino

Abstract

We provide benchmarks to evaluate what is an optimal foreign debt and a maximal foreign debt (debt-max), when risk is explicitly considered. When the actual debt exceeds debt-max, then the economy will default when a "bad shock" occurs. This paper is an application of the stochastic optimal controls models of Fleming and Stein (2001), which gives empirical content to the question of how one should measure "vulnerability" to shocks, when there is uncertainty concerning the productivity of capital. We consider two sets of high- risk countries during the period 1978-99: a subset of 21 countries that defaulted on the debt, and another set of 13 countries that did not default. Default is a situation where the firms or government of a country reschedule the interest/principal payments on the external debt. We thereby explain how our analysis can anticipate default risk, and add another dimension to the literature of early warning signals of default/credit risk.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2001/wp-cesifo-2001-04/cesifo_wp469.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 469.

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Date of creation: 2001
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Handle: RePEc:ces:ceswps:_469

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Related research

Keywords: Default risk; foreign debt; stochastic optimal control; debt rescheduling; uncertainty;

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References

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  1. Wendell H. Fleming & Jerome L. Stein, 1999. "A Stochastic Optimal Control Approach to International Finance and Foreign Debt," Working Papers 99-23, Brown University, Department of Economics.
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Cited by:
  1. Wendell Fleming & Jerome L. Stein, 2002. "Stochastic Optimal Control, International Finance and Debt," CESifo Working Paper Series 744, CESifo Group Munich.
  2. Miguel Messmacher & Mark Kruger, 2004. "Sovereign Debt Defaults and Financing Needs," IMF Working Papers 04/53, International Monetary Fund.
  3. Jerome L. Stein, 2003. "Stochastic Optimal Control Modeling of Debt Crises," CESifo Working Paper Series 1043, CESifo Group Munich.
  4. Jerome L. Stein & Guay C. Lim, 2004. "Asian Crises: Theory, Evidence, Warning-Signals," CESifo Working Paper Series 1159, CESifo Group Munich.

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